What is Pre-IPO
Pre-IPO (a pre-initial public offering) investments mean investing in fast-growing and privately held companies several months or years prior to their listing on any public stock exchange.
At the pre-IPO stage investors “freeze” their investments for a longer period in the hope of receiving quality assets. And an investor exits a pre-IPO deal after the company becomes public or is sold to a strategic investor.
Stages of Business Growth
To better understand Pre-IPO you should know there are several stages of business growth. And at each stage, there are new challenges and also financing sources.
1.The seed phase is the initial stage of a project. The goal is to develop the idea for a new product or service. At this stage, the focus is on matching the business opportunity with skills and experience, deciding on a business ownership structure and other focus points. A business idea is tested for its viability. During the seed stage, the entrepreneur is using his own money or no money at all, just investigating.
2. Early-stage is when the business has developed a product and has it on the market and is starting to generate some revenue and profit from customers, getting the first metrics, feedbacks, and is developing a business model. At this point, the company needs a financial boost. That usually comes from their own money, friends, relatives.
3. Growth stage is about achieving sustainable scaling. Business is focusing on growth and increasing profits and the number of customers. At this phase, owners are searching for partners and collaborators. The main money sources are profits, government, banks (and might be also investors).
4. The expansion stage is when the company is seeking exponential growth and looking to improve efficiency and productivity. The focus at this stage might be on business strategy, infrastructure, leadership capability, building a team, developing an improved product. At this stage it’s also important to open up to new markets and segments. This phase requires even greater financial support, for example, from new investors, to provide major expansion of a company that has increased sales and is profitable. This is when the most Pre-IPO investments come in because business models have gained stability and, through the expansion, grow very fast so they need funds for further expansion, marketing, development.
5. Exit phase comes after the long path of a startup. After all the effort and hard work, the business can be sold or shut down. If the entrepreneur chooses to sell the business, there will be needed some effort and financial advising to make the company worth more to the buyers. That’s why IPO (Public Offer of Sale) prices are higher than pre-IPO. Interestingly, some years ago it was evident that after the expansion phase companies invest more in the business growth to get to the exit phase sooner. But now companies choose to stay longer in the expansion stage.
Why Invest in Pre-IPO Funds?
Pre-IPO shares are cheaper than IPO shares
It’s your chance to buy long-term companies at a cheaper cost as the buyers in a pre-IPO placement usually get a discount from the price stated in the prospective for the IPO.
The potential profit
The early investors benefit the most before the company goes public so investing in a pre-IPO has the potential to get the highest returrns on investment and get even more than 200% to capital in a few years.
In recent years, more startups succeed in getting funding, and as a result, their valuation grows before IPO. Many “unicorns” are valued at over 1 billion dollars.
The absence of stock market uncertainty
Pre-IPO investments aren’t as affected by events like the financial crisis or the pandemic that trigger shifts within the stock market as shares are not yet made public.
Easier exit route for investors
If the investors would want to sell out their stake in the IPO to get the capital gains faster, it would lead to more supply of shares and hence lower prices. But the Pre-IPO investors can liquidate their holdings as soon as the company goes public as they are replaced by new investors who intend to hold shares for longer.
Risks and disadvantages
Pre-IPO investments has medium-high risk. There’s low chance of loosing part or all the principal, mid-high chance of IPO not happening in 1-3 years, in which case investor has to keep the investment for longer (3-5 years).
Temporary uncertainty and the lack of information
A seller of stocks knows more information than a new buyer. Companies have no obligation to provide investors with financial information about the company while public companies must procure financial reports which are audited.
Also, an investor usually doesn’t know the supposed IPO date.
Companies might postpone IPO
We will select companies that demonstrate signs of going public within 1-3 years, however, these signs are indirect.
There is a risk that the company will postpone IPO for a longer period to stay private for longer. Even though an IPO can be an effective way for companies to access large sums of capital, some of them are choosing another way. For example, in the United States, the number of publicly listed companies dropped by 52% in 2016 compared to 1996.
And there are no guarantees that the public listing will even occur.
Risk of loss
There is not an exchange for private shares, so if you want to sell your investment there is no guarantee you will find a buyer.
Buy shares of companies that expressed an intention to get listed on the stock market in several years!
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